I am a Professor of Economics at Texas Christian University, where I have worked since 1987. My areas of specialty are international economics (particularly exchange rates), macroeconomics, history of economics, and contemporary schools of thought. During my time in Fort Worth, I have served as department chair, Executive Director of the International Confederation of Associations for Pluralism in Economics, a member of the board of directors of the Association for Evolutionary Economics, and a member of the editorial boards of the American Review of Political Economy, the Critique of Political Economy, the Encyclopedia of Political Economy, the Journal of Economics Issues, and the Social Science Journal. My research consists of over thirty refereed publications, two edited volumes, and one book (with another in process). I have also been lucky enough to win a couple of teaching awards.
In terms of my approach to this blog, I am a firm believer that economics can and must be made understandable to the general public, but that our discipline has done a very poor job in this regard. This is particularly true of macro issues, where people quite naturally assume that their personal experiences are analogous to those at the national scale. Very often, this is not the case, with the result that politicians and voters (and some economists) press for policies whose effects are quite the opposite of what was intended. That this is problematic has never been more evident than today. I also try to steer as clear of politics as possible. I want to explain how things work, not what you should believe.
I have been married to my wife, Melanie, for over twenty-five years, and we have twin daughters (who have just started college) and a dog named Rommel (who has not). My favorite pastimes are online computer gaming and reading about WWII history.

Obama + Ryan = Catastrophe

Between Democratic President Barack Obama and Republican House Budget Committee Chair Paul Ryan, it appears that one way or another we are facing big budget cuts. In fact, this process has already started. I addressed at length the folly, even insanity, of this policy in a previous article here at Forbes.com:

But the issue is sufficiently important to warrant another post–hell, another ten, if necessary. We are in the midst of committing national economic suicide and there is absolutely no reason for it. In point of fact:

the federal government’s budget is not analogous to a private one;

the federal budget doesn’t ever have to balance;

deficits generate higher levels of economic activity than would otherwise be possible; and

China doesn’t own the United States regardless of how many Treasury Bills they have.

However, as all that is covered in the article linked above, I wont’ go over it again here. Instead, let me frame the issue in a slightly different manner. It’s called the sectoral balances approach and anyone can understand it fairly quickly. What it will show is that federal government surpluses suck wealth out of the private sector.

Say that our entire economy is composed of two people: Alex and Meg. They work, produce output, earn incomes, spend, etc. Say further that there are no government or foreign sectors. It’s just Alex and Meg. Notice something: their total spending must also be equal to their total income. How can they spend money in a manner that it does not become somebody else’s income, and how can they earn income except as a result of the another’s spending? This is actually true in any macroeconomic unit, whether it is two people or 200 million. It’s just easier to see in the former case.

Now here’s a corollary to this simple economic identity: whenever Alex spends more than she earns, Meg earns more than she spends. When Alex is in deficit, Meg is in surplus; and when Alex is in surplus, Meg is in deficit. This is a very basic lesson often taught in introductory finance courses and it easily extends to a more complex system. It basically says that the sum total of all deficit spending in an economic system is exactly equal to the total of all surpluses.

To see how this works, imagine the following conditions. Assume a financial system that allows Alex to borrow $10,000. Also allow Meg and Alex to buy output made by their own factories. Were this not the case, one’s income would always be identical to the other’s spending, which is not necessary in the real world when Meg and Alex are entire sectors of the economy (and can therefore have internal transactions–people who work at the pretzel factory can buy pretzels):

INCOME Alex: $50,000 Meg: $40,000 Total: $90,000 (remember that this must be equal to total spending!!!)

SPENDING Alex: $60,000 Meg: $30,000 Total: $90,000 (remember that this must be equal to total income!!!)

Meg’s financial wealth has increased by $10,000. She earned $40,000 and spent $30,000, so must have the rest in financial assets and cash. Meanwhile, Alex is $10,000 in debt. And it always works this way. Since spending and income must logically be the same number, there is no way for one person’s deficit not to be exactly equal in magnitude to the other person’s surplus. It’s impossible. Try plugging in other numbers while holding to that rule and you’ll see what I mean.

Now change “Alex” to the “US federal government” and “Meg” to the “private sector” and note this critical fact: whenever the government spends in deficit, private sector wealth increases; and when the government runs a surplus, private sector wealth declines. That’s not a trick, it’s simple arithmetic. Government surpluses suck wealth out of the market. Of course they do, because they represent really high taxes relative to government spending. That’s like the US private sector having a trade deficit with respect to its own government. We become increasingly indebted to them.

This is what Obama and Ryan are trying to accomplish today. They call it budget balancing, but what if we labeled it “private sector wealth destruction?” “Budget balancing” has a very positive, responsible ring to it and thus at a gut level we are all in favor of it. It just has to be a good thing, doesn’t it? But would we be rushing to embrace “private sector wealth destruction?” Of course not. To be sure, what Obama and Ryan are talking about at first are only smaller deficits and not surpluses per se, but a) reducing the debt will eventually require surpluses and b) a sector I left out for simplicity, the foreign one, is also currently in surplus (for us this means a trade deficit), which also reduces private sector wealth. In other words, if we have a balanced budget for the federal government at the same time foreigners have a surplus, this means a net deficit for private citizens and firms–wealth destruction.

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It looks fine on my PC, although what you mention was an issue when I first loaded it. I quickly corrected it, and once I reloaded it it was fine not only across different browsers, but also when I checked on other PCs. Not sure what’s going on but will check.

Ahhh, indeed, on my wife’s PC, where I am not logged into my Forbes author account, the problem appeared. It is not here, incidentally:

http://blogs.forbes.com/johntharvey/

As I am pretty sure I actually fixed all the formatting problems and this is just an issue with the server lagging updates, however, I’ll leave it for now. If it’s still there later, I’ll see what I can do.

Thank you again for reading and commenting. I have tried to break the discussion into parts below so that it is easier to manage.

********COST-BENEFIT OF GOVT SPENDING ********

I have read through your discussion a number of times now and I think it’s safe to say that we have a very different understanding of how a modern industrial capitalist macroeconomy operates. Take this statement, for example:

GM: “There is a big problem in Keynesian theory. As I said, there is no cost/benefit analysis of government expenditure. No one knows what the value of a public expenditure is. There is certainly a cost, often exorbitant, but no analysis of results.”

I’m not a Keynesian, so you may well be right about their view of the world, but as I suggested both above and in the original piece on the debt and deficit, there is most clearly a cost-benefit analysis going on, just not the one you have in mind. The traditional version of such an approach asks the question, “How else might these resources have been used?” I sense that is the view you are taking: had the workers not dug holes and filled them (which we certainly would not want them to do, but I’ll continue with that example since it biases the argument against me), then what would they have done instead? Here is the key to understanding my approach: they would have done nothing. They would have remained involuntarily unemployed. Thus, the framework for the cost-benefit analysis is not, what would they have done in the private sector versus what would they have done in the public sector? Rather, it is, what would they have done sitting around at home waiting for work versus what would they have done in the public sector?

Furthermore, even if we put them to work digging and filling holes (which, I cannot overemphasize, we would not want them to do in reality), that still creates goods and services because the private sector has excess capacity. When we hand out the paychecks to the hole diggers, that makes the production of more goods and services in the private sector profitable, and they hire more workers, too. That is what I’m discussing on page two of this article:

GM: “At the end of the project, idle people were paid to produce nothing. They supplied nothing of value for the $1 billion received. They did not build any houses. They did not build cars. They did not enforce the law. They did not create any saleable or valued product. They did not lower costs for any business or person. If none had bothered to show up while still receiving pay, the result would have been the same financially.”

Correct, which is why we wouldn’t actually pay people to dig and refill ditches. However, as I argued above, even if they did not personally add to total output, the fact that they now made private sector activities more profitable DID do so–that’s the whole point. What does the military add to our output, particularly in peace time? Absolutely nothing of market value. But, soldiers, sailors, airmen, marines, etc. take their paychecks and shop at WalMart, Ford, Target, etc., etc., and thereby make jobs for others in the private sector (while, not insignificantly, making them safe in their beds at night). It’s no different, and it absolutely adds to output.

In the next part of the discussion (starting with “Now suppose that the government never went ahead…”), you assume away the core problem we are addressing in the first place. Of course it is quite right that if the private sector would have generated the same level of demand, then there is no reason for the government to do so–but they don’t and they won’t. To reiterate, you are assuming that the macroeconomy has an automatic tendency to full employment. Now there is no issue to resolve. It’s a bit like discussing how to go about curing a cancer patient and suggesting that we assume she no longer has cancer.

********BORROWING VS TAXATION********

In another place, you write:

GM: “If the government collects the funds entirely by taxation…”

One of the major conclusions of both my pieces on the debt and deficit is that this is not what we should do and so using that in an example of how my argument is false is not a legitimate representation of what I’ve been saying. I have been specifically saying NOT to do this.

You later suggest that we fund via borrowing. You continue to assume that hiring even ditch diggers has no positive effect on output, which it does, and then argue that the debt becomes a burden on the private sector when it is, in fact, a financial asset that they have added to their portfolio. Furthermore, you seem to assume that this debt must be reduced to zero at some point–why is this? I addressed this in the first debt and deficit article. It is not true.

********RELATIVE MERITS OF KIND OF SPENDING********

You write here:

GM: “Now suppose the nation decides to shelve the diggers’ project and educate the idle to become engineers.”

You then go on to point out that this would be more profitable. Fair enough, no one had been arguing otherwise.

********KEYNESIAN ECONOMICS********

You write here:

GM: “You say that government would be foolish to fund the digging and filling in of holes. But this is veritably what Keynesians advocate.”

As I am not a Keynesian, I’m not sure of the relevance of this criticism. I don’t agree, but it’s beside the point.

********INFLATION********

We apparently fundamentally disagree on this issue! Here is what you write:

GM: “It was not caused by rising oil prices. Rising oil prices were a symptom of the same cause spurring the prices of all other items: Governments funding through taxation”

I find it difficult to picture how any government monetary or fiscal policies led the OPEC countries to, as a direct result of the 1973 Arab-Israeli War, band together to set quotas that drove up oil prices. This was a political act. Government borrowing had absolutely nothing to do with it, and what occurred instead was that as prices rose, so this led entrepreneurs to borrow more money for operating costs. Central banks, as they should have done, obliged, and this drove up money supplies. Hence, rising prices drove up money supplies and not the other way around–which is the way it is in the real world almost without exception (albeit not in the world where helicopters are used to increase the money supply!).

2) Treasury could and should print as much money as possible because they are not taxes and they are not issued to U.S. citizens, companies, China or anyone else.

3) Printing as much money as possible is not inflationary because the Chinese lent us the money before we even printed the money by buying treasury securities that were never issued to them, so inflation was already there.

4) If Gold were money, and we found a way to print gold and print a lot of it, we did not create a lot of money.

5) Our central bank print money by buying US treasury securities from the public. US treasury securities that they shouldn’t have had since they were never issued to U.S. citizens or companies, China or anyone else.

6) Those who own US treasury securities would not sell it, ever, because it is a voluntary transaction. Therefore it is impossible for treasury holders to dump their US treasury holdings and cause us inflation.

7) Inflation can only happen when we print money near full employment and no where else. Since we are no where near full employment, inflation can not happen.

8) Because the government issues its own currency, it can spend as much as it wants without causing inflation. Anyone tell you otherwise is either senile or a liar.

9) We shouldn’t worry about China buying US treasury because we could print as much cash as we want to pay them back. And, the Chinese would never sell our treasury securities. Even if the Chinese does sell our treasury and want to buy US company with that money, we are not going to allow this “dictatorship”, this “insult to the memory of Adam Smith” to buy our company. No, China can only buy US treasury.

10) A government surplus is called “private sector wealth destruction” and the private sector deficit is called “wealth destruction” therefore we should make all private deficits, government deficits: public deficits.

11) “federal government cannot go bankrupt in debt it owes in dollars” so the government should print as much dollars as possible to help the private sector and raise government deficit because there are no ill effects.

“1) It is not logical to borrow money when we could simply print them.”

There is a logical reason to make them borrow, but it is political, not economic.

“2) Treasury could and should print as much money as possible because they are not taxes and they are not issued to U.S. citizens, companies, China or anyone else.”

Not as much as possible. The real key is that the government is creating employment in the macroeconomy. The printing money bit is how we finance it, so it’s a means rather than an end.

“3) Printing as much money as possible is not inflationary because the Chinese lent us the money before we even printed the money by buying treasury securities that were never issued to them, so inflation was already there.”

No, it would, indeed be inflationary eventually, but not until we reach full employment.

“4) If Gold were money, and we found a way to print gold and print a lot of it, we did not create a lot of money.”

Not sure what you mean. I’ll say this about gold: the problem is that the volume is determined by geology, not the need to finance economic activity.

“5) Our central bank print money by buying US treasury securities from the public. US treasury securities that they shouldn’t have had since they were never issued to U.S. citizens or companies, China or anyone else.”

No, the public should have Tbills as they were used to finance earlier deficits. And then the Fed can buy them back to create new money.

“6) Those who own US treasury securities would not sell it, ever, because it is a voluntary transaction. Therefore it is impossible for treasury holders to dump their US treasury holdings and cause us inflation.”

No, they may sell it, but as you say, it’s voluntary. Hence, the situation described by Monetarists in which the central bank increases the money supply beyond demand is impossible–like haircuts, you can’t supply money in the absence of demand for it.

“7) Inflation can only happen when we print money near full employment and no where else. Since we are no where near full employment, inflation can not happen. “

It can happen for other reasons (like OPEC), but, yes, if we create new cash that is not inflationary unless the creation of that cash doesn’t lead to the creation of goods and services.

“8)Because the government issues its own currency, it can spend as much as it wants without causing inflation. Anyone tell you otherwise is either senile or a liar.”

No, it can, indeed, cause inflation, but, as you said in #7, only near full employment.

“9) We shouldn’t worry about China buying US treasury because we could print as much cash as we want to pay them back. And, the Chinese would never sell our treasury securities. Even if the Chinese does sell our treasury and want to buy US company with that money, we are not going to allow this “dictatorship”, this “insult to the memory of Adam Smith” to buy our company. No, China can only buy US treasury.”

Sort of. We could, indeed, just print cash to pay them back, but why would they suddenly want to cash out? If they did, they would cause a collapse in the value of an asset they are holding. The stuff about Adam Smith in the article was actually unrelated to this point.

“10) A government surplus is called “private sector wealth destruction” and the private sector deficit is called “wealth destruction” therefore we should make all private deficits, government deficits: public deficits.”

The point there was that government surpluses destroy private-sector wealth. Unless there is some other advantage to doing so, we shouldn’t!

“11) “federal government cannot go bankrupt in debt it owes in dollars” so the government should print as much dollars as possible to help the private sector and raise government deficit because there are no ill effects.”

First bit is right, it can’t go bankrupt in debt it owes in dollars. However, there is no reason to print as many dollars as possible. Again, the only reason for all this is to finance fiscal policy aimed at lowering unemployment. The monetary policy in and of itself is only a means to a much more important process.

I fear, if your suggestions were adopted by our politicians, that would cause World War III: the war to foreclose on America. I don’t believe other countries would sit idly by and watch their investments in US treasury securities to wither away by inflation. I also fear that your idea could create a fatal vulnerability in the US dollars that could make a deliberate attack on our economy possible.

What we have now is a recession, maybe even a depression, but we could recover in time. But, If we were to do what you have suggested, and cause hyperinflation, our savings will be destroyed, and the economy will be in total chaos for sometime. In the mean time American scientists, investors, engineers, teachers, and skilled workers will all be spirited away to other nations: a repeat of what we did to the Soviet after their financial collapse.

I don’t think the Chinese like us very much, nor do I think that the new Russians or the Europeans would not try to take advantage of us.

The potential economical, political, and territorial benefits of land and sea China and others could gain from a stunned America far outweigh some reduced assets or even forfeiture of just a trillion dollars of US treasury securities.

Think of Taiwan, the Korean peninsula, the Asian Pacific, the northern passage, and the sphere of influence that China, Russia, the EU , and every other country in the world could gain if America were out of the picture because of our economic chaos from hyperinflation?

Japan is already in a bad state, I believe the Japanese will sell our treasury securities if pressured, since they can no longer afford to take any more losses now. Combine that with China’s holding, government stimulus, QE1 and QE2, we are already in a precarious situation.

If there is anymore money pumping, we could be at the mercy of our enemies.

Money is a medium of exchange. It, by itself, only stores the material value of which it’s made of. The US dollar is worth what we agree upon as its worth. “We” in this case are the users of dollars. The users of dollars are all people who use dollars as a medium of exchange, i.e. trading partners: sellers and buyers. Trading partners are not limited by races, genders, countries, or geographic locations. As long as a trade were conducted using dollars, trading partners that were involved in that trade, traded dollars. Traders of dollars determine what it’s the worth of dollars by evaluating and reevaluating the purchasing power of dollars. Purchasing power is how much a currency can obtain by using itself as a payment for goods and or services. It is for this function and this function only that dollars store value and people save it.

Dollar inflation is the decrease of purchasing power by the dollars as a medium of exchange. It is the lost of real value of the dollars because trading partners demand higher payment for the same goods and or services. This lost of value is caused by the lost of confidence, a fear that an equal value of goods and or services could not be returned for the same amount of dollars. The lost of confidence is caused by the brazen violation of contract. The mutual agreement of trade is based on the value of the exchange and not the medium of the exchange.

If goods and services were sugar then dollars are magical bags that contain that sugar. These magical bags always have the same amount of sugar as other magical bags of the same currency. If there is more sugar then every bag will have more sugar so the amount of sugar between any two bags is always the same. Inflation is having more bags without adding sugar so it is the same as it were taking sugar out of each existing bag, making all bags having less sugar. Traders wanted sugar, not bags; therefore they would demand more and more bags to have the same amount of sugar. The taking of sugar from all bags means stealing sugar from people who are savers of sugar who use those bags, and those who use those bags in exchanges. It is the same, as if the sellers of dollars went back in time and broke every single deal and contract ever made and paid a lower amount in its place.

Your argument that money printing would not cause inflation is wrong because printing money always deteriorates the worthiness of money. It is only when the same amount of value are added to the amount of money printed, could that money maintains its value, and that value is determine by the traders of dollars.

No nations, no savers, no traders of US dollars would sit idly by and watch their dollar’s values rot away by inflation. Before then, they would switch to another currency. As I mention before, this also leaves an opportunity for our enemies to stun us. If your ideas were ever employed, we could face hyperinflation. In hyperinflation American people would lose virtually all our purchasing powers, our savings would be destroyed, and our economy would halt and go back to a bartering system.

“Your argument that money printing would not cause inflation is wrong because printing money always deteriorates the worthiness of money.”

That is actually not true as it is based on the assumption that the level of output remains the same. If output rises, there is no inflation. I won’t write this all out again as I did so already in here:

Your first blog post sparked my interest in Post Keynesian economics, and I have been trying to read up about it as much as I can. As someone schooled in conventional economics, I know that it is difficult to shake some of the underlying assumptions that make your arguments seems illogical. The two main hurdles to overcome in my opinion are the quantity theory of money and the traditional money multiplier. Once you overcome the belief that printing money is always inflationary (most people accept this as a no-brainer), then the rest of the things you are saying make a lot more sense. I wondered if you could devote a future post purely to those two aspects?

Howdy, Ben! Indeed, all of us were originally taught Neoclassicism, and Keynes’ words ring true:

“The ideas which are here expressed so laboriously are extremely simple and should be obvious. The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds.”

With respect to future posts, I do, indeed, plan to do one on money and prices. It seems to come up so much. Actually, one of the original arguments with respect to this can be found here:

[...] is what John T. Harvey explains in his Pragmatic Economics column at Forbes, Obama + Ryan = Catastrophe. I stole John’s simplified sectoral balance explanation, so I guess I owe it to him to send a [...]

[...] is what John T. Harvey explains in his Pragmatic Economics column at Forbes, Obama + Ryan = Catastrophe. I stole John’s simplified sectoral balance explanation, so I guess I owe it to him to send a [...]

[...] is what John T. Harvey explains in his Pragmatic Economics column at Forbes, Obama + Ryan = Catastrophe. I stole John’s simplified sectoral balance explanation, so I guess I owe it to him to send a [...]

After having just read all this stuff and now retiring to lie down in a dark room with a cold compress on my forehead, a quickie: Businesses are surely focused on spend/income (=turnover)only in as much as it is a ratio of the profit margin. It’s profitability that ensures continuity, not volume and therefore I have difficulty in accepting you ceteris paribus scenario – too simple, methinks, or is that only me?.

Dr. Harvey, I am not an economist, but I am a businessman. I am relieved to finally read something that exposes some myths in economics however. I do believe that most of our politicians are ignorant of the facts and so they go along with the myths. It seems all people somehow think that paying back the debt is necessary for the survival of the country but fail to see that if we eliminated the debt, we would virtually eliminate most of our money supply leading to deflation (horrors)and a completely dead economy. I believe the population is mislead into believing that this debt is “owed to other countries and people”. The belief is that the burgeoning debt will need to be repaid with interest and that that interest and principal will have to come out of the citizens pockets in the form of crippling taxes and the cancellation of all future social programs including their pension. It boggles the mind that people do not realize that with every increase in population there is also a requisite increase necessary in the money supply and that without that, there would be deflation, or massive unemployment or both. But I have one question for you: Why is the population kept ignorant of the facts, and why is basic economics not taught in schools? With an ignorant population, all kinds of horror stories are propogated by the media and believed. Our country is in for a very rough landing if the facts are not finally disseminated.

John, as the comments posted show, there is much theory (alternative and conflicting in many cases) and what ifs involved in any discussion of economics, particularly when talking about the largest economy in the world (if that is still the case).

However, if it really is as simple as you make it seem, why does the Government, with its teams of advisers, consultants and experts not simply adopt your reasoning and methodology?

Thanks for explaining this whole thing for me in a “See Spot Run” kind of way. Although I am familiar with accounting an finance, and I took both micro and macro economics in college from Walter Heller at the University of Minnesota, I’m basically a “right brained” person, who loves literature, history, art and philosophy (I’m an Aristotlian, not a Platonic). I’m also a lawyer in 3 states (MN, TX and IL) and a devotee of Ayn Rand and her epistemology. However, I worked in business in a Sales and Marketing capacity for half my life, and the other half in the legal arena and in government acquisitions, so I know the FAR and DFARs backwards and forwards. Thanks for you help on this. I’m a Republican, so this is crucial to my understanding. Once again, thank you for explaining this to me in a simple and easy to understand way.

Interesting article. But lets take it a step further. Meg and Alex are sittin on a deserted island with 5 other people.

All people have the combined skills to make a good life, but they do not because Alex does not want what Meg produces, she wants what Mary produces, but Mary wants what Jane produces and Jane wants what Robyn produces.

No one person is prepared to exchange with the other because they do not want what is being produced by the other although the other wants what they produce.

I step in and introduce the idea of currency.

I lend each and every one of the islanders $50 and allow them to exchange currency for products and thus an economy results.

I am now the Federal Reserve Bank. I charge interest.

After a while, Mary has spent more than she has produced and I lend her more money at a slightly higher interest rate because she is a “bad risk”. Jane is a much smarter business woman and also starts making some private “loans”. After a while, Jane and the Federal Reserve have siphoned off quite a t of the available currency.

I also introduce the idea of “taxes” so that we can build infrastructure on the island. I also “lend money” to the island as a whole so that the infrastructure can be built. This creates a short term economic boom because indebted Mary can now get extra work building the infrastructure and, Jane being very smart, I contract to manage it. She also gets a LOT richer. Everyone is happy. Economy is booming and some other people get “shipwrecked” and arive on the island. They also get jobs in the booming economy.

Taxes get paid ad the Federal Reserve Bank gets paid by the taxes for the money tha they created out of thin air.

The island becomes more indebted to the Bank.

After a while, people start t protest the fact that their taxes have risen to 30% of their income. The money being pulled out of the economy by these taxes starts to create a downturn i the economy and people become upset.

The economy begins to falter and the newly elected government decides that the taxes must be lowered. Lowering the taxes spurs the economy and a mini boom occurs. But the debt gets bigger because the interest owing is greater than the taxes being paid, and so the government needs to borrow mre money from the Federal Reserve just to pay the interest…